Author: Joseph N. DiStefano

As pension funds and other investors have cut back new private equity investments after years of poor returns, Wall Street private equity managers such as Apollo Global, Blackstone, and KKR have moved more heavily into corporate lending.

They compete with banks to make loans but aren’t bound by the rules that govern banks. The managers bundle the loans into private credit funds and offer them to investors as an alternative.

“Everyone has shifted to private credit,” which should make investors extra careful, warns Richard Vague, chairman of Pennsylvania’s $80 billion school pension system, PSERS.

Scholars at Yale Law School cite estimates that private credit funds are approaching $2 trillion in assets, up from $300 billion in 2010, and they’re on track to double in the next two years.

As private credit funds have grown, analysts warn that limited information about the loans makes it hard to know what the credit funds are worth or how they would respond to a slowing economy.

For example, Philadelphia-based FS KKR Capital Corp., one of the largest and oldest private credit funds, and two of its rivals have won unwelcome attention for posting very different prices for their investments in the same Silicon Valley private-equity takeover loan.

Such ambiguity doesn’t exist in publicly traded securities such as stocks, where investor assumptions are reflected in the market price at any given time. The conflicting private-credit valuations suggest analysts aren’t certain about how likely the private credit funds are to get their money back or to lose money if loans default.

“Risk is on the move. We’re talking trillions‚” Mark Pinto, head of private credit at Moody’s Investors Service, told clients in a recent report.

Different from banks

While banks have rules for measuring and publicly reporting loan losses and late payments — and private credit managers say they, too, apply strict internal standards — Moody’s analysts in that report called private credit loan reporting “opaque.” They cited private credit risk as a rapidly growing area of concern to financial systems.

The rapid growth is new, but private credit has long history.

FS KKR was set up as a publicly traded business development company and opened to investors in 2009 by Future Standard (formerly Franklin Square), a Philadelphia-based investment firm headed by Michael Forman and cofounded by college-housing baron and Sixers co-owner David J. Adelman.

That fund is marketed by FS, but its investments are managed by staff at FS’s partner, private-equity giant KKR. It invests about $20 billion of FS’s total $86 billion in client assets, FS reported last year.

While FS KKR paid shareholder dividends of 70 cents a share — or most of its profits in recent quarters — shares have lately traded around $15, down from the low $20s last year, a sign that investors are concerned about prospects in a slowing economy.

In a widely reported example that points out the difficulty of measuring the value of the loans in these funds, FS KKR’s share of a loan to finance the 2021 purchase of Medallia, a Silicon Valley-based customer-service software company, was listed on KKR’s books last fall at 91 cents on the dollar, a discount of 9% to its original value, as confirmed in an SEC filing. A discount implies FS KKR has some doubt the borrower will pay its loans on time.

But a rival Apollo Global fund listed the same loan at a 23% discount, as if Apollo saw a significantly higher risk that Medallia wasn’t going to pay.

SEC records show a third private credit fund run by real estate giant and private-credit pioneer Blackstone listed the Medallia loan at an 18% discount.

How can the same loan have three different values?

Detailed public reporting on Medallia’s finances had almost stopped since yet another private-equity and private-credit investor, Chicago-based Thoma Bravo, paid $6.1 billion in 2021 for the company. Thoma Bravo took Medallia private and borrowed from FS KKR, Apollo, Blackstone and others to help fund the deal, Leyla Kunimoto, a former KPMG auditor noted in a post on her credit review platform, Accredited Investor Insight.

That leaves investors trying to glean intelligence from limited information or trusting fund managers with their differing views and valuations.

So what’s the loan really worth?

KKR partner Daniel Pietrzak, who is both president and chief investment officer for FS KKR Capital Corp. and head of Global Credit at KKR, said pricing differences “can arise naturally” for loans that aren’t publicly traded.

Factors include “variations in valuation providers, timing, policy nuances and available information,” he added in a statement. So, for example, one of the investors might know something others don’t.

Pietrzak said KKR pays “independent third-party valuation providers as part of a robust and consistent process, which helps ensure valuations fairly represent asset value across our portfolio.”

These specialized loan-value estimators include firms such as Lincoln International LLC in Chicago, Valuation Resource Corp. (VRC) in New York, and an affiliate of the Duff & Phelps advisory group.

The Medallia loan totaled $1.8 billion at 6.5% interest. Many of the other loans in the funds are smaller and are used to finance midsized businesses, potentially spreading the risk if a few borrowers go broke, or compounding it in case of a widespread financial recession.

FS KKR, like some other private-credit funds, “should incorporate higher discount rates for stressed credits,” including lower valuations for loans by companies with other outstanding loans that aren’t getting paid on schedule, said Rob Dubitsky, a former Credit Suisse managing director and Moody’s analyst who now heads The People’s Economist, a financial-analytics start-up.

“These valuation and disclosure issues are not unique” to the FS KKR fund but are reflected in private credit funds’ recent weak share performance and low credit ratings from Moody’s and other agencies, Dubitsky wrote in a recent article.

FS KKR was rated Baa3 by Moody’s last year and BBB- by Fitch. Those are the lowest investment-grade ratings above junk bonds. Lower ratings are for entities analysts expect are more likely to default, which would discourage many investors.

While Moody’s analysts and other observers expect private credit funds to continue their recent rapid growth, investors watch their opportunities closely, and may shift course.

For example, private equity has generally “underperformed” compared to public investments for most of the past five years, PSERS chief investment officer Ben Cotton told trustees at the board’s annual reorganization meeting Jan. 9. So he said he’s thinking it may be time to consider new private equity investments: “We are getting to where we may have opportunities and want to be ready.”

Small-business advisers and advocates are bracing for a wave of questions as the city’s Business Income & Receipts Tax (BIRT), Philadelphia’s municipal tax that hits both sales and profits, expands to cover tens of thousands of small businesses and self-employed workers as they pay their 2025 taxes.

City revenue officials expect to collect more than $35 million in new BIRT payments this year from the expanded pool of taxpayers, even with slightly lower tax rates.

Businesses are concerned not only about the cost of the tax but also trying to follow the city’s complex business tax rules and incentives, even as the city prepares to spend millions helping first-time business taxpayers.

“This is applicable to every sole proprietorship, limited-liability company, incorporation, or partnership engaged in a business, profession, or activity for profit in the City of Philadelphia,” said Scott S. Small, trust counsel in the Philadelphia-area office of Fiduciary Trust International, a New York-based advisory firm for families and business owners.

“Think of folks that have houses they rent. Daycare in their homes. For-hire drivers at Uber or Lyft. Estates and trusts that own property,” Small said. “A return now has to be filed, regardless of whether you made a profit.”

Even with extensive city guidance, “it becomes a logistical nightmare” for small taxpayers, who may have to hire professionals to figure out what they owe and exemptions that can reduce the total, said Will Gonzalez, who runs CEIBA, a Latino business and economic education group.

Business taxes and the general difficulty of doing business in Philadelphia were “the number one issues” reported in a survey of 200 city businesses by the Independence Business Alliance, a chamber of commerce for LGBTQ+ business owners, that was presented to members of Mayor Cherelle L. Parker’s tax reform commission last year, said Zach Wilcha, the alliance’s chief executive.

“Small businesses pay on revenues, sales, profits [there is a separate net profits tax along with the BIRT income tax], and wages,“ Wilcha said. ”People love being in Philadelphia; they want to stay here. But they feel the tax structure is forcing them to leave.”

Eliminating the BIRT’s income tax and curbing the revenue tax has been a longtime goal of business advocacy groups like the Chamber of Commerce for Greater Philadelphia. It was a goal of business members on the tax reform commission. City leaders in the end decided on gradual rate reductions instead, a move tax commission chair Richard Vague called “disheartening.”

The BIRT tax rate on sales is dropping by half a penny per $1,000 this tax season to $1.41 per $1,000 of sales. And the income tax is decreasing to $57.10 per $1,000 of profits from $58.10. The city plans to slowly cut the revenue tax to zero and the BIRT income tax by half by 2039.

But this year, far more taxpayers will be paying the tax, which is due by April.

Philadelphia formerly exempted businesses that gross less than $100,000 in sales per year from paying BIRT. That exemption failed to survive a court challenge. Under the “uniformity clause” of the Pennsylvania state constitution, taxes can’t exempt whole classes of taxpayers based on income.

“It’s the same reason we can’t have a [state or local] tax just on billionaires, or millionaires,” Small said.

A smaller-business exemption on the city’s use and occupancy tax exemption is also gone, leaving more small-business owners liable for that 1.21% a year tax, paid in monthly installments.

A bill proposed by Councilmember Mike Driscoll that would exempt solo entrepreneurs from paying the business income and revenue taxes has not advanced in Council.

The city collected around $680 million in BIRT business taxes last year, about 10.5% of city revenues.

Among Pennsylvania communities, only a minority, including Radnor Township and other Main Line communities, charge similar business taxes.

Kathleen McColgan, Parker’s revenue commissioner, says Philadelphia expects to collect “an additional $35 million to $40 million in fiscal year 2026″ from the broadened BIRT. The city has earmarked that money for “commerce and business development.”

City officials have said they will spend $7.5 million this year for programs to help new taxpayers figure out how to manage the city’s complicated tax programs and exemptions.

In recent years, the city has collected BIRT from around 40,000 larger businesses, McColgan said. She estimates that 50,000 businesses that have paid other city taxes will start owing BIRT for the first time. Roughly 25,000 other registered businesses that hadn’t incurred any taxes in recent years before might also owe.

City officials could provide no estimate of how many businesses that never registered to pay taxes may be required to pay BIRT for the first time.

To spread the word, McColgan said the city sent around 80,000 notices to registered business taxpayers in and outside the city, plus 119,000 postcards to businesses “who may have a responsibility to file” from lists the city purchased from a private vendor.

Besides the promised multilingual tax education and assistance for first-time filers, officials noted that the city has an array of tax discounts that can reduce the small-business burden.

First-time filers can get an extension if they can’t get the form in by April 15, but they will still owe the tax accruing from that date with any late fees.

And, after the first year, taxpayers are expected to pay the next year’s BIRT in advance, in quarterly installments.

Even with the city’s initial guidance, many first-time taxpayers will need professional help to navigate all those rules and realize available discounts, Small said. “It’s a nightmare” for a layperson to attempt to follow all the instructions and file correctly.

“People want to pay their taxes,” CEIBA’s Gonzalez said. “It’s the right thing to do. They also need to pay their taxes, if they want to buy a house or send a child to college.

“But anyone who is going to pay the BIRT for the first time is going to need a city business license. And for that, they have to pay any outstanding tickets and bills. And that can be a lot to resolve all at once.”

His group and others have held online and remote workshops to advise drivers, independent home-health aides, and other first-time BIRT payers.

Gonzalez predicted “a rude awakening for Philadelphians” as the tax fits in. “Our economy is built on a lot of this gig work, and we’d hate to see people punished for making more money for their families.

“And this puts people in Philadelphia at a disadvantage. In a year we are celebrating the 250th year of the American Revolution that started with unfair tax concerns, we need to find a better way.”

Small, of Fiduciary Trust, said the Philadelphians he advises tend to complain without leaving the city. “Folks kind of suck it up, and say, ‘It’s not as bad as it could be.’”

Still, many people have noticed how the city and state also offer incentives to bring in new businesses that aren’t given to regular taxpayers, he said. “The small guy gets the higher burden, while larger ones who have more ability to pay, pay less.”